--IMPORTANCE--
“You know you’re priced right when your customers complain—but buy anyway.” – John Harrison [Pricing News Daily, 2014].
““Pricing is the only element in the marketing mix that produces revenue; the other elements produce costs.” — Phillip Kotler.
--PRICING METHODS--
--COST-PLUS (MARK-UP) PRICING--
COST-PLUS PRICING is often used by retailers. They take THE PRICE THAT THEY PAY THE PRODUCER/SUPPLIER, and then just ADD A PERCENTAGE (%) MARK UP. The size of the mark up usually depends upon a combination of the strength of demand for the product, the number of competitors, and the age and stage of life of the product. Sometimes it also depends on traditional practice in the industry.
For example, If the cost of bought-in materials = $40, and the retailer wishes for a 50% mark-up on cost = $20, the selling price = $60.
--PROS--
Price set will COVER ALL COSTS of production.
EASY TO CALCULATE for single-product firms where there is no doubt about fixed-cost allocation.
Suitable for firms that are ‘price makers’ due to market dominance.
--CONS--
Not necessarily accurate for firms with several products where there is doubt over the allocation of fixed costs.
Does not take market/competitive conditions into account. For example if your competitor lowers price then you will be uncompetitive.
Tends to be INFLEXIBLE, e.g., even though
--PENETRATION PRICING--
PENETRATION PRICING is a strategy where a company SETS A LOW INITIAL PRICE FOR A NEW PRODUCT/SERVICE TO ATTRACT CUSTOMERS QUICKLY AND GAIN MARKET SHARE. The goal is to encourage trial, build brand loyalty, and discourage competitors. Once the customer base grows, the company may gradually increase prices.
It is often utilised by FIRST MOVERS IN A NEW INDUSTRIES, who wish to maximise short-term profits, before competitors enter the market with a similar product, and to project an exclusive image for the product. If rivals do launch similar products, it may be necessary for the price to be reduced over a period of time.
--PROS--
LOW PRICES LEAD TO HIGH DEMAND– it is important to establish high-market share for new products.
If demand is high, the business MAY BE ABLE TO RAISE PRICES AFTER A PERIOD OF TIME to increase profit margins.
--CONS--
PROFIT MARGINS MIGHT BE LOW – prices might have to increase in the future and there could be consumer resistance to this
It could START A PRICE WAR – and if competitors have more resources they might be able to survive this better
Low price might be PERCEIVED AS LOW QUALITY.
--LOSS LEADER--
LOSS LEADERS refer to PRODUCTS SOLD AT A LOSS to attract customers. The goal is to bring customers into the store where they are likely to purchase other items that have higher profit margins. This strategy can also help to build customer loyalty and increase market share.
Makes a loss on one product but this is more than COMPENSATED BY PROFITS ON OTHER PRODUCTS – perhaps complementary to the loss leader
Increases market share.
Cheaper generic alternatives might be sold by rival firms so the profit-making complementary products are not purchased from the loss-leading business.
--PREDATORY PRICING--
PREDATORY PRICING is an ILLEGAL pricing strategy where a company SETS PRICES SIGNIFICANTLY BELOW COST with the INTENTION TO ELIMINATE COMPETITION, after which it can raise prices to recoup losses and maximize profits. This practice can lead to monopolistic control and is considered anti-competitive and illegal in many jurisdictions. It is difficult to prove that this is predatory pricing because it can be seen as price competition and not a deliberate act to eliminate competitors.
Drives down prices to benefit consumers and is likely to increase demand for the product.
May reduce the number of competitors in the long term and increase monopoly power of the ‘predator’
It is illegal in many countries and, if proven, heavy fines can be imposed.
Consumers may try to find alternative products if the business achieves market power dominance and increases prices in the long term.
Consumers may perceive a lower quality product.
Find a real world example of predatory pricing and create a
--PREMIUM PRICING--
PREMIUM PRICING, also known as prestige pricing or luxury pricing, is a strategy where a company SETS THE PRICE of its products HIGHER THAN SIMILAR PRODUCTS TO SIGNAL HIGHER QUALITY, EXCLUSIVITY, and STATUS usually using extensive marketing to built the brand's reputation. This status may be justified due to better materials and expertise or simply achived through pursuasive brand promotions. Luxury brands all use this type of pricing.
Do you think TES uses this strategy?
Helps to establish a PERCEPTION OF EXCLUSIVITY and high brand image
Consumers might ASSOCIATE HIGH PRICE WITH HIGH QUALITY.
Will only be effective if part of a coordinated mix which helps to establish a premium image for the product.
Could lead to LOW SALES and revenue if consumers switch to lower-priced competitors
--DYNAMIC PRICING (HL)--
DYNAMIC PRICING as the name suggests involves SETTING CONSTANTLY CHANGING PRICES. The practicality of this method has been enhanced tremendously through e-commerce due to the way that prices can easily be changed (automated in most cases) and how consumers cannot tell what other buyers are paying.
Businesses can VARY THE PRICE ACCORDING TO DEMAND PATTERNS or knowledge that they have about a particular consumer and their ability to pay.
MAXIMISES REVENUE by setting different prices for different consumers
Varies the price according to market conditions and the price elasticity at different times
Can be used to IMPROVES STOCK MANAGEMENT – cut prices to sell excess stock
Requires advanced IT systems to adjust prices quickly according to changing demand levels
CONSUMERS DISLIKE THE SYSTEM as it is viewed as a form of exploitation
Consumers may be ALIENATED if they find out some buyers have paid a much lower price.
--THINKING TASK--
Do you think supermarkets can use dynamic pricing? Watch the video below and deide for yourself!
--COMPETITIVE PRICING (HL)--
COMPETITIVE PRICING refers to a pricing strategy where a business SETS THE PRICE of its products or services BASED ON THE PRICES OF COMPETITORS. This approach is often used by producers of products with many close substitutes and without any obvious differentiation, in order to AVOID A PRICE WAR WITH CURRENT COMPETITORS, who would retaliate if price was lowered and TO AVOID LOST SALES if price was raised above its cheaper substitutes.
Helps to maintain market share and even increase sales if all businesses in the market set low prices.
Avoids setting prices which are much lower than rivals’ prices, which will reduce profit margins
Helps to build customer loyalty if they can be assured of receiving a competitive price
May reduce profit margins if prices are set to respond to low-priced competitors
Some rivals might have lower average costs, and pricing competitively will risk the business making a loss
Setting competitive prices below cost will risk long-term survival
--CONTRIBUTION PRICING (HL)--
CONTRIBUTION-COST PRICING is SIMILAR TO COST-PUSH PRICING in that you add a %, however you are focused on this amount covering your variable costs per unit, and the extra amount is known as a contribution to fixed costs.
But why? Often a firm wishes to, or is forced to lower its price (Maybe to get rid of some excess stock or offer a discount) so it sets the price to a level that makes it worthwhile staying open. Meaning its price covers its variable costs per unit and any excess will contribute to its fixed costs. Note that this is only a TEMPORARY PRICING METHOD.
Sets prices that could be lower than the cost-plus method so makes the business more competitive.
Avoids the inaccurate allocation of fixed costs which can lead to inappropriate prices.
Does not include fixed costs in the pricing decision.
A loss will be made if total contribution is less than fixed costs.
Cannot be sustained in the long term if fixed costs are not being covered.
--PED (HL)--
“You know you’re priced right when your customers complain—but buy anyway.” — John Harrison
PRICE ELASTICITY OF DEMAND (PED) is a term you mainly hear in economics refers to a measure of the RESPONSIVENESS of QUANTITY DEMANDED of a good to CHANGES IN the PRICE of the good. It helps firms know whether a change in price will result in GREATER or LOWER TOTAL REVENUE (TR = Selling price (P) * Quantity sold (Q))
Based on the LAW OF DEMAND, which states PRICE and QUANTITY DEMANDED have an INVERSE RELATIONSHIP, we could initially assume that a higher (lower) price and lower (higher) quantity demanded would result in less (more) TR, however the opposite can also be true depending on the PED value.
If we look below we see that the price change for both goods is the same, an increase of $1 or 25%, yet the fall in quantity is different, Good A experiences a 33.33% fall, while Good B only experinece a 10% fall. Now if we look at the changes in TR, we can see that both Goods initially earned $1200 ($4 * 300) but after the price hike, due to Good A's relatively larger response in terms of the fall in quantity demanded TR has decreased to $1000 ($5 * 200), while as a result of the relatively less responsive fall in quantity demanded for Good B, the TR has actually increased to $1350.
--GOOD A (ELASTIC)--
--GOOD B (INELASTIC)--
So we say that the PED for Good A over the price range $4-$5 is MORE ELASTIC (RESPONSIVE) to Price changes, and therefore the RISE IN PRICE is NOT ADVISABLE, whereas the PED for Good B over the price range $4-$5 is MORE INELASTIC (UNRESPONSIVE) to Price changes, and therefore the RISE IN PRICE is ADVISABLE. This also applies when there is a fall in price.
We can go a step further and turn this responsiveness into a value using the following formula:
If we plug in the percentage changes above we get the following:
Good A PED = -33% / 25% = 1.33
Good B PED = -10% / 25% = 0.4
We can clearly deduce that value LESS THAN 0NE represent INELASTIC DEMAND, while values GREATER THAN ONE represent ELASTIC DEMAND
The FEWER SUBSTITUTES a good (or service) has, the MORE INELASTIC is its demand. If the price of a good with few substitutes increases, consumers can't switch to other substitute products, therefore resulting in a relatively small drop in quantity demanded. e.g. petrol
Also if the good is ADDICTIVE, such as tobacco or alcohol, then there are few substitutes, and its demand as a whole will be inelastic.
The MORE SUBSTITUTES a good (or service) has, the MORE ELASTIC is its demand. If the price of a good with many substitutes increases, consumers can switch to other substitute products, therefore resulting in a relatively large drop in the quantity demanded. E.g. Coke Cola & Pepsi
NECESSITES are goods or services we consider to be essential or necessary in our lives; and which we cannot do without them. The demand for necessities is usually INELASTIC. For example, the demand for medications/masks tends to be very inelastic because people’s health or life depend on them; therefore, quantity demanded is not very responsive to changes in price. The demand for food is also inelastic, because people cannot live without it.
LUXURIES are goods or services we consider to be NON-essential in our lives; and which we can do without them. The demand for luxuries is usually ELASTIC. For example, the demand for diamonds tends to be very elastic because people do not rely on them for survival.
The LOWER the proportion of one’s income needed to buy a good, the more INELASTIC the demand.
For example, SALT takes up a SMALL proportion of income, as such a 5% increase in price should result in only a very small fall in demand.
The HIGHER the proportion of one’s income needed to buy a good, the more ELASTIC the demand.
For example, BIG SCREEN-TVS takes up a LARGE proportion of income, as such a 5% increase in price should result in only a very small fall in demand.
The GREATER the degree of BRAND LOYALTY, the more INELASTIC the demand.
The WEAKER the degree of BRAND LOYALTY, the more ELASTIC the demand.
Making more accurate sales forecasts. If a business is considering a price increase, perhaps to cover rises in production costs, then an awareness of PED allows a forecast of likely demand changes to be calculated. For instance, if PED is believed to be −0.8 and the price is increased by 10%, what will be the new weekly sales level if it is currently 10 000 per week? Demand will fall by 8% (check this out using the PED formula) and this will give a forecast sales level of 9 200 per week.
Impact on pricing decisions. If an operator of bus services is considering changing its pricing structure, then knowing the PED on different routes will help. It could increase prices on routes with low PED (inelastic demand) and reduce them on routes with high PED (elastic demand). These decisions will increase the total revenue of the bus operator.
If a business is planning to use premium pricing, it would be assuming that demand is relatively price inelastic so that the high price will not result in a proportionately greater reduction in demand. Revenue should increase if demand is price inelastic. If a business is planning to use penetration pricing, it would be assuming that demand is relatively price elastic so that the low price results in a proportionately greater increase in demand. Revenue should increase if demand is relatively price elastic.
PED assumes that nothing else has changed. If Business A reduces the price for a product by 10%, it will expect sales to increase because of this. However, if, at about the same time, a competitor leaves the industry and consumer incomes rise, the resulting increase in sales of Business A’s product may be substantial, but not just because of the price reduction. Calculating PED accurately in these and similar situations where other changes occur will be almost impossible.
A PED calculation, even when calculated when nothing but price changes, will become outdated quickly. It may need to be recalculated often, because over time consumer tastes change and new competitors may bring in new products. Last year’s PED calculation may be very different to one calculated today if market conditions have changed.
It is not always easy, or indeed possible, to calculate PED. The data needed for working it out might come from past sales results following previous price changes. This data could be quite old and market conditions might have changed. In the case of new products, market research will have to be relied upon to estimate PED. This is done by trying to identify the quantities that a sample of potential customers would purchase at different prices. This will be subject to the same kind of inaccuracy as other forms of market research.